June 15, 2011

This holiday from committing liberal history began in December with the White House-GOP deal that extended the Bush tax rates through the 2012 election and added a payroll tax cut on employees to 4.2% from 6.2%. These proposals came from the same Democrats who only months earlier had increased payroll taxes to finance their health-care bill and routinely claim that tax rates don't matter to the private economy. But then, 9.1% joblessness and 1.8% growth have a way of concentrating the political mind.

The Journal here is conflating two completely different beliefs. One idea is that marginal tax rates are extremely important in determining the incentive of workers, investors and entrepreneurs; raise marginal tax rates too high, and they won't bother to work hard or innovate. The extreme version of this dynamic, called "supply-side economics," deems these incentive dynamics so crucial that they determine the entire course of the economy.

A completely different idea here is Keynesian economics. That idea holds that, when the economy is depressed, it makes sense for the government to encourage people to spend more. The government can do this by cutting taxes temporarily, thus putting more money into the hands of consumers, or by spending the money directly.

The two concepts have nothing to do with each other. The first idea is concerned with the supply of labor, focused on marginal tax rates(the tax rate on your last dollar of income), especially for the rich, and applies to any set of economic circumstances. The second is concerned with the demand for labor, takes no account of marginal tax rates, encourages tax breaks for lower-income workers who are more likely to spend, and applies only to recessions.

The Obama administration, like most economists, has never put much stock in supply-side economics. Most economists believe that marginal tax rates affect supply a bit, but the effect is small, especially at current tax rates. (We might be running into trouble at 50% or higher.) That's what the Journal means when it says Obama thinks "tax rates don't matter to the private economy" -- it's a wild exaggeration, naturally, but an exaggeration of a basic truth. At the same time, Obama has followed orthodox Keynesian response to a severe depression, which is to run high-short term deficits in order to stimulate demand. Obama did include a payroll tax hike in the Affordable Care Act -- on high-income earners, to take effect starting in 2013, by which point the economy was presumed to be in recovery mode.

In the Journal's telling, Obama has flip-flopped -- he opposed the Bush tax cuts, and now he's proposing tax cuts? But of course the 2009 stimulus had tax cuts, too. Obama has favored and continues to favor short-term Keynesian tax cuts, and continues to oppose George W. Bush's permanent supply-side tax cuts. I genuinely couldn't tell you whether the Journal editorial page simply fails to understand the very basic difference in economic doctrines, or is simply pretending not to understand in order to concoct a political narrative to use against Democrats.